SOVEREIGN EURO DEBT CRISIS

Rashmita Bora (E 61) Shivani Mehta (E 12) Prateek Saini ( E 27) Barun Bhattacharya (E 56) Abdul Azeem (E 24) Nupur Mittal (E 21)

INTRODUCTION
Historically, financial crisis have been followed by a wave of governments defaulting on their debt obligation Financial crises tend to lead to, or exacerbate, sharp economic downturns, low government revenues, widening government deficits, and high levels of debt, pushing many governments into default Greece is currently facing a classic sovereign debt crisis

Greece debt crisis is actually an evolution of the global crisis Greece allowed deficits from Central Bank and government bonds to pile up Greece debt came into light in 2009 On May 2, 2010, the Eurozone members and International Monetary Fund (IMF) endorsed a historic 110 billion (about $145 billion) financial package for Greece in an effort to avoid a Greek default and to stem contagion of Greece's crisis to other European countries, particularly Portugal, Spain, Ireland, and Italy.

TRANSMISSION FROM UNITED STATES

US Housing Bubble created by

Low interest rates Lax regulation of sub-prime mortgages with adjustable rates, two year teaser rates Securitization of mortgages, sold to unwary buyers as highly rated
Interest rates rose in 2006, housing prices fell Subprime mortgages and securities defaulted

US Bubble popped when

CAUSES

Rising Government Debt Levels: Maastricht Treaty was signed under which it was pledged to limit their deficit spending and debt levels, but no. of EU states circumvent these rules & mask their deficit & debt levels through the use of more complex currency & credit derivative structures. Increased debt level- large bailout packages provided by financial sector during late 2000s financial crises & global economic slowdown thereafter. Average fiscal deficit in Euro area in 2007 was 0.6% which grew to 7% during financial crises and the Government debt rose from 66% to 84% of GDP. Trade Imbalances: Germany had a considerably better public debt and fiscal deficit relative to GDP than the most affected euro zone members. In the same period, these countries (Portugal, Ireland, Italy and Spain) had far worse balance of payments positions. Whereas German trade surpluses increased as a percentage of GDP after 1999, the deficits of Italy, France and Spain all worsened.

Monetary Policy Inflexibility Membership of the euro zone establishes a single monetary policy, individual member states can no longer act independently. This situation created a higher default risk than faced by smaller non-euro zone economies. Loss of Confidence: Prior to development of the crisis it was assumed by both regulators and banks that sovereign debt from the euro zone was safe. Banks had substantial holdings of bonds from weaker economies such as Greece which offered a small premium and seemingly were equally sound. As the crisis developed it became obvious that Greek, and possibly other countries', bonds offered substantially more risk. Contributing to lack of information about the risk of European sovereign debt was conflict of interest by banks that were earning substantial sums underwriting the bonds. The loss of confidence is marked by rising sovereign CDS prices, indicating market expectations about countries' creditworthiness. Furthermore, investors have doubts about the possibilities of policy makers to quickly contain the crisis. Since countries that use the euro as their currency have fewer monetary policy choices (e.g., they cannot print money in their own currencies to pay debt holders), certain solutions require multi-national cooperation.

EURO-DOLLAR EXCHANGE RATE

EUROPEAN BOND SPREADS

EUROPEAN BOND SPREADS (II)

HIGH INDEBTEDNESS IN THE PERIPHERY

CONDITION OF GREECE
Greece has been downgraded to the lowest in the Eurozone, meaning it will likely be viewed as a financial black hole by foreign investors. Greece struggling to pay its bills as interest rates on existing debts rise. Greece has been taking help from various countries to overcome its crisis Greece to increase sales taxes, reduce public sector salaries, pensions, eliminate bonuses.

IMPACT ON EUROPEAN ECONOMIES

The Greece debt crisis has had a domino effect on the European countries It has reduced the confidence in the European countries Fiscal deficit and public debt have gone beyond the ceilings regulated by the Stability and Growth Pact Standard & Poors decreased the Greek debt rating to junk amidst fears of default

Yields on Greek government two-year bonds rose to 15% following the downgrade, and stock markets worldwide declined On May, 2011, two euro zone countries and the International Monetary Fund agreed 110 billion loan for Greece On May 9, Europes finance minsters approved a comprehensive rescue package almost worth a trillion dollars aimed at ensuring financial stability across Europe

IMPACT ON US ECONOMY

THREAT TO US EXPORTS

The devaluation of the Euro triggered by the debt crisis made American exports more expensive. It has depreciated by nearly 15%(from 1.44 to 1.23) Government spending and exports have been the only two growth engines of the American economy Industries that are most dependent on European trade include chemicals, transportation, computers and electronics. Obama said, "If Europe is weak, if Europe is not growing, as our largest trading partner, that's going to have an impact on our businesses and our ability to create jobs here."

US BANKS ARE TETHERED TO THOSE IN EUROPE

The banking sector calls for a big threat as the financial markets across the Atlantic are highly integrated with each other. U.S. banks have about $700 billion in outstanding loans in Great Britain, which isn't directly affected. They have about $300 billion each in France and Germany, the leaders of the Eurozone. And they have about $50 billion each in Italy and Spain countries that could be dragged into default if the crisis escalates. The impact here could be felt on several levels: Employees of European banks such as UBS and Deutsche Bank could see their jobs threatened if a recession hits Europe and those employers retrench. U.S. banks could further tighten credit to small businesses in this country.

U.S. companies' investments in Europe at stake The Eurozone is the biggest market for U.S. companies with direct foreign investments. More than half the sales of American-owned foreign affiliates are in Europe The potential impact on individual investors -Global equity markets are highly reactive to events in Europe. A 'dramatic effect' on the 2012 election? The experts say that this would impact the upcoming elections in the US.

IMPACT ON INDIAN ECONOMY

ACCORDING TO CARE

India's exports are positively linked to the global economic growth. This is likely to adversely impact India's export growth in the coming months. However, growth will be only marginally affected by the slowdown in the euro region debt stricken countries as our exposure is low. Software services and other export oriented sectors would benefit from the rupee depreciation. FDI has not been significantly affected by the crisis while the FIIs are showing outflow in the last couple of months. International commodity price moderation is not being translated in domestic prices. Further, exchange rate depreciation would worsen the inflationary conditions in the economy. Therefore, the RBI would have to continue with its anti-inflationary stance in the near term if domestic conditions do not improve.

It has been observed that in 2010-11, Indias exports to the European region and US moderated. However, our exports to the Asian and the African region, which have a greater share in Indias exports, grew during this

The rupee has depreciated by 18% against the Dollar and by around 9% against the euro since Aug 2011. This trend is likely to improve the competitiveness of this sector. The negative impact, if any, will be marginal

IMPACT IN INDIA

ITALY

Italys borrowing costs have soared and its stock market has tumbled during these past few days on concerns about Italys ability to deal with its large debt problem and concern over a growing rift between Italian Prime Minister Silvio Berlusconi and Italian Finance Minister Giulio Tremonti , a man who the markets hold in high regard Italy is a country that top European officials should be concerned about since it has a lot of ongoing problems which could threaten the stability of Europe. Italy has a Debt to GDP ratio of 120% , which is treacherously high considering that 90% is seen by people as the threshold when a country is in dangerous territory.

Italy has struggled to grow its economy for the past several years, which has hampered its ability to pay down its debt . Italy's borrowing costs is seen as "unsustainable" over the long-term (10-year borrowing costs are over 5.6% at the time of this writing) . Italys economy is more than twice the size of the combined economies of Greece, Portugal, and Ireland. A recent article by Zero Hedge suggests that a default on Italys debt would cause much greater financial problems in Europe than a debt default by Greece and arguably could cause more financial problems in Europe than a debt default by Germany-Europes strongest and most important

The recent events in Italy may be part of a bigger event that is beginning to impact the larger economies of Europe.

The Royal Bank of Scotlands Chief European Economist, Jacques Cailloux , was quoted saying that he and his firm believes that the larger European economies are beginning to experience the effects of the debt crisis that has impacted Portugal, Ireland, and Greece

SPAIN

Spains borrowing costs are approaching unsustainable levels (its 10-year borrowing costs are above 6% at the time of this writing ). Spain is dealing with the aftermath of its real estate bubble bursting The true debt/deficit levels of local governments in Spain are not fully known (in fact one region of Spain reported on Monday that its deficit is doubled what it previously reported ).

Spain has youth unemployment levels above 40%

The size of Italy alone is too large for the E.U. to bailout with the funds currently at its disposal. The German newspaper Die Welt reported on Sunday that the E.U.s rescue fund is insufficient to handle a rescue of Italy. Die Welt suggests that the E.U.s rescue fund may need to be doubled to 1.5 trillion Euros to handle a rescue of Italy . If Spain gets into more trouble the E.U. may need to increase the size of its rescue fund even more.

European countries have already committed hundreds of billions of Euros in the rescue of Greece, Portugal, and Ireland in the past 18 months. Despite the hundreds of billions of Euros that Europe has committed in the past 18 months, Greece now requires a second bailout and Portugal may soon need a second bailout .

CONCLUSION
The crisis wont stop for a period of time till all the debt obligations in euro-zone are not cleared. The situation is because the euro countries are dependent on each other. Hence the countries are not able to repay the debt to countries they borrowed from and hence the lender is in a threat of going into debt crisis.

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